Apple: UBS Ups to Buy, $650 Target, on Institutional Money Reversal

By Tiernan Ray

Shares of Apple (AAPL) are up $8.51, or 1.5%, at $559.74, defying a down market, following an upgrade this morning by UBS’s Steve Milunovich to Buy from Neutral, and an increase in price target to $650 from $540, based on Milunovich’s belief that institutional money will rotate into the stock in 2014, in part as it flees stocks such as International Business Machines (IBM) that are subject to incursions from cloud computing.

A number of factors will act to repair sentiment on Apple stock, writes Milunovich:

Apple became a stalled growth stock though not a broken company. Now we think that perception of Apple and an improved multiple are likely as (1) money moves from threatened legacy tech stock to Apple, (2) the additions of carriers DoCoMo and China Mobile aid the seasonally weak summer quarters, (3) gross margin stabilizes, and (4) new products such as wearables and iBeacon increase confidence in Apple’s innovation. The Dec quarter benefits from the bevy of recent product announcements. Long term, we agree with Apple’s strategy of focus and a premium user experience. Although there is risk from “good enough” technology, history favors companies that choose better over cheaper.

Milunovich chronicles what he sees as the risk to enterprise tech firms such as IBM and Accenture (ACN), and the depressed rate of institutional flows into Apple shares:

Tech is in transition from the client-server to IT-as-a-Service era. Traditional vendors are under attack, including IBM, HP, EMC, Oracle among others. It is a confusing time. However, Apple generally is on the right side of secular trends in that SMAC technologies (social, mobile, analytics, cloud) mostly benefit the company. Social and mobile increase demand for its devices while analytics and cloud support back- end services. Also, the consumerization of IT plays to its advantage. Apple has competitive challenges, but the industry wind is at its back. As a result, we expect investors will continue to move money from legacy vendors to Apple’s stock. Moreover, Apple has room to further boost its capital return program whereas many tech names have limited room for improvement. Management said it would indicate any changes early in the new year. We don’t expect a change at this point, but Apple has firepower to increase debt and buybacks. In the meantime, shareholders get a 7% return combining the 2% yield and 5% reduction in shares. While Apple’s stock has improved, institutional ownership has not recovered. It peaked at about 73% in April 2012 and has fallen to under 64%. Our sense speaking with investors is that many are now equal or underweight Apple relative to their benchmark, which could result in new money supporting the stock. Apple fits the value description and with potential double- digit EPS growth in F14 could show up again as a growth story. When Apple’s stock was cooking, it occasionally sold at par with the market. The discount was as much as 30% last spring and now sits at 15- 20%. We think the discount could narrow further given Apple’s high ROIC and more pleasing capital return policy. What’s missing now is better revenue and operating earnings growth.

Milunovich offers the following chart of institutional ownership (click for larger image):

Milunovich thinks a deal to carry the iPhone officially at China Mobile (CHL) is about to happen, and that it could boost iPhone sales by 10 million units, helping to offset slumping sales in the March quarter:

Recently, both China Telecom and China Unicom increased the monthly fee for the iPhone 5S to $60 per month. These pricing plans suggest that the Chinese carriers subsidize roughly 40-50% of the device or at least $550 per phone. We think China Mobile’s handset subsidy budget in 2013 is Rmb27bn (around US$4bn), going to perhaps Rmb35bn ($5.2bn) in 2014. If Apple were supported by 20-30% of CM’s subsidy budget, that would be about 2-5mn iPhones. We also note that sales through CM might be limited by the fact that most of the iPhones sold in China are sold through Hong Kong to avoid the consumption tax. Despite these potential subsidization limits, an agreement with China Mobile still could translate to sales of more than 10mn units annually given the carrier’s 70- 75% share of high-end subscribers. Recall in 2012, CM noted that more than 25mn iPhones were on its GSM network. Although other vendors, notably Samsung, probably have stolen many of those users, we think Apple’s brand power should win over a fair number of the less price-conscious subset.

Milunovich also opines the hiring of Burberry CEO Angela Ahrendts to run the retail business could benefit Apple by putting a woman in senior management.

“Her version of Jobs’ intersection of technology and liberal arts is that she now considers herself half right- and half left-brained. She naturally is more right- brained (liberal arts) but became more analytical working for Donna Karan.”

He notes a tweet recently from Salesforce.com (CRM) CEO Marc Benioff pronouncing Ahrendt the “future Apple CEO.” Writes Milunovich, “She and [Apple CEO Tim] Cook are about the same age, so for her to become CEO Cook might need to retire prematurely.”

“Or perhaps she will become president and a clear #2.”

Milunovich also likes “iBeacon,” Apple’s technology for pushing messages to iOS devices based on GPS he-location:

We think iBeacons helps level the playing field between physical and online stores. iBeacons also gives the customer more privacy control than facial recognition technology. So the technology and potential benefits are fairly clear—how does Apple make money? The company said for now it is focused on implementation and demonstration of the technology, letting the retail community develop innovative applications. Apple won’t make much on the beacons themselves, which are low-level technology. Sell more iPhones because they are a better smartphone for shopping and indoor GPS generally […] Charge license fees […] Move into payment stream.

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DECEMBER 3, 2013 1:26 P.M.

Who put pickle juice in my coffee?! wrote:

Would someone explain to me. Please. We used to have AAPL price targets in the neighborhood of $900 to over $1100. Right. Then there was the huge sell off at $700. Right. So what's changed? Why are all or almost all of these new price targets at the sub $700 level? Explain. Thank you.

Shouldn't we be seeing price targets rolling in that are super 700 and more. C'mon.

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.